Labour's fiscal policy: Marks for effort

The UK election campaign, which is being met with indifference at home never mind abroad, took a radical turn today with the publication of the Labour Party’s manifesto. Much of what was leaked last Thursday was included in today’s plan, with one or two additions, and it is very much a series of tax and spend proposals which offers a radical alternative to the economic status quo of market over state. It is, I suspect, the economic plan of a party which does not expect to win an election: Many of the proposals would simply not be acceptable to higher earners or corporates, which will bear the brunt of additional tax rises. At a time when companies have to think about where they want to be located post-Brexit, it is a plan which will encourage footloose capital to move elsewhere. Nonetheless, it does raise very big questions about the nature of the state and the role of fiscal policy, which have been neglected for too long.

The philosophy which the UK electorate has bought into since Thatcher’s time is that a relatively small state is a good thing and that markets provide freedom of choice. But this is not always true. For one thing, private companies are not always as efficient as their proponents claim because they waste resources in the competitive process which could otherwise be used more effectively for service provision – a bit like moving parts which generate heat rather than mechanical energy. Whilst on the whole, they do deliver lower cost services there are real questions as to whether private entities are run for the benefit of shareholders or their customers.

In a competitive market the two sets of interests are aligned, but certain industries are best viewed as natural monopolies. Gas, electricity and water supply all fall into this category and so unpopular is the notion that private sector energy companies are ripping off the consumer, that the Conservatives have stolen one of Labour’s old ideas by planning to impose price caps (what price free markets?). Nor are huge infrastructure projects  necessarily suited to a private sector which does always not have the scale to manage them properly. For example, the UK has outsourced the construction of the Hinkley Point nuclear power station to EDF – a French state-owned company – and a state-backed Chinese entity. The first decade after the privatisation of the UK rail network was characterised by a shambolic series of events which means that today, the Labour Party’s policy of re-nationalising the rail network is actually very popular (it plans to do this as local franchises expire which means that the cost to the Exchequer is limited).

Of course, not all privatised utilities are bad. No-one would seriously advocate renationalising the telecoms network. But it is right to have a debate about which industries require more state involvement, and we should not dismiss the issue as being one for the socialists. Incidentally, the privatisation programme sparked by the Thatcher government in the 1980s was designed to create a nation of small shareholders, in which households held a stake in the nationalised utilities. But that idea faded quickly as shares were snapped up by institutions which in turn sold out to foreign utilities. Whatever the rights and wrongs of today’s energy and water markets in the UK, what we have now is not what was envisaged in the 1980s.

Looking more closely at Labour’s plans, there was more detail on the tax and spending pledges which will result in a tax rise of £48.6bn by the end of the next parliament, or just over 2% of GDP. According to the sober analysis of the Financial Times, this would put taxes relative to GDP at their highest since 1949. But even then, the state will still be significantly smaller than in many other European countries. As I noted last week, a large chunk of the additional taxes will fall on corporates, which are expected to contribute almost £20bn of the £48.6bn increase, and another £6.4bn from higher income taxpayers in what the Daily Mail helpfully described as Corbyn’s class war. What was truly radical was the idea that a Labour government would “consider new options such as a land value tax” which ironically was supported by the likes of Adam Smith, a hero of many on the Conservative right.

It is questionable whether these figures would ever be realised, however. Raising taxes changes the behaviour of those on whom the tax is levied so if tax elasticities are high, revenues may well be far lower than anticipated. Nonetheless, Labour did a good job of allaying fears of an unfunded rise in current spending, even if many people will be less than happy about the prospect of higher taxes. A potential Labour government will, of course, have to borrow to fund its capital spending plans. That is normal. At issue is how much it would need to borrow and what would the market charge. I suspect we will never get the chance to find out.

Even if one does not like the ideas presented today, they represent a rather more grown-up approach to the question of fiscal policy than we have become used to in recent decades. If we want a better healthcare system, we are going to have to pay for it. More policemen? Fine, but the money has to come from somewhere. There is, however, a whiff of the 1970s about the plan. It fails to account for the fact that more money does not necessarily mean better services. It also treats the UK as a small closed economy whereas in reality a globalised environment will pose limits on the government’s ability to operate the fiscal levers. A former Labour prime minister, Jim Callaghan, recognised as such in 1976 when he said “We used to think that you could spend your way out of a recession, and increase employment by cutting taxes and boosting Government spending. I tell you in all candour that that option no longer exists.” Still, I will give Labour marks for trying, and we should not be too surprised if some its ideas ultimately end up being adopted by the Conservatives. It would not be the first time.